Temporary Trade Truce Buoys Markets

The market gyrations that characterized October continued through November, leaving the major domestic stock indices essentially flat for the month. The same issues were on investors’ minds, namely trade issues, tech sector volatility, Brexit negotiations and Italian debt. Although economic data for the United States has been relatively positive, concern seems to be building that the pace of economic and earnings growth will slow in 2019, explains Nick Lacy, chief portfolio strategist for Raymond James Asset Management Services, exacerbated by declining sentiment and global growth measures.

“Slower growth doesn’t mean a contraction,” Lacy clarified. “Things are actually in pretty good shape, which gives me reason to believe the markets will be fine.”

After months of elevated tensions between the U.S. and China, investors welcomed news of a trade ceasefire that emerged from the G20 summit over the first weekend of December. President Trump and China’s President Xi agreed to halt tariff escalation for now and continue dialogue on the more difficult questions of China’s structural reforms with a 90-day timeframe. Given the challenges ahead, negotiations may begin to fray, and the threat of a tariff hike to 25% (with an additional tariff package as further leverage) could re-enter market considerations, explains Washington Policy Analyst Ed Mills.

In the immediate term, China will begin purchasing a yet to be determined quantity of U.S. agricultural, energy and industrial products. China also signaled willingness to institute stricter controls on opioid exports. This arrangement is essentially a “lite” version of the nixed agreement in May. However, an encouraging sign is that the terms have expanded to broader questions in the spirit of negotiating a larger deal, and the worst-case scenario of significant immediate-term escalation has been put on hold, Mills added.

12/29/17 Close

11/30/18 Close

Change YTD

% Gain/Loss YTD

DJIA

24,719.22

25,538.46

+819.24

+3.31%

NASDAQ

6,903.39

7,330.54

+427.15

+6.19%

S&P 500

2,673.61

2,760.17

+86.56

+3.24%

MSCI EAFE

2,050.79

1,809.56

-241.23

-11.76%

Russell 2000

1,535.51

1,533.27

-2.24

-0.15%

Bloomberg Barclays U.S. Aggregate Bond Index

2,046.37

2,008.62

-37.75

-1.84%

Performance reflects price returns as of 4:30 EDT on November 30, 2018.

Here is a look at what’s happening in the economy and capital markets, as well as key factors we are watching:

Economy

The first half of next year should bring more fiscal stimulus in the form of tax cuts and government spending, which should support growth, but the impact is expected to fade in the second half, Brown notes.

The pace of future rate increases is uncertain, but the central bank is expected to raise rates more slowly in 2019. Fed Chairman Powell recently noted that the federal funds rate “remains just below the broad range of estimates of the level that would be neutral for the economy – that is, neither speeding up nor slowing down growth.” However, most Fed officials see the neutral rate as higher than the bottom of the range.

Powell’s hint that we are near neutral and that the central bankers are considering a more flexible approach did not escape the attention of market observers, like Chief Investment Strategist Jeff Saut.

However, with both sides far apart on major issues (such as intellectual property rights), investors will likely remain guarded until they see actual progress. “For this reason, we do not budge from our stance that the S&P 500 will remain range-bound, trading (low to mid-2600s to mid-to-upper 2800s) in the coming months.” Gibbs said. “The news only causes us to believe the market remains in the mid-to-high end of the range in the coming weeks.”

With substantial manufacturing in China, numerous companies were at risk of margin compression if tariffs moved up to 25%. The consumer discretionary sector is a beneficiary as well with products bound for the U.S. originating in China.

With the S&P 500 still down 6% from the September peak and with over 53% of the stocks in the index down at least 15% from their 52-week highs, ample opportunity remains, he notes.

Fixed Income

Given that the Fed left the discount rate unchanged in November, there remains a high probability that the central bankers will hike rates in December according to market expectations. Per the most recent Fed dot plot, another three to four rate hikes are anticipated in 2019.

It’s likely that the bond market will continue to react to market conditions, and investors can expect some volatility in the near future. For example, the latest 10-year Treasury yield fell from 3.227% on Nov. 6 to 3.02% toward the end of November, points out Doug Drabik, senior fixed income strategist.

While there has been ample attention paid to the equity markets over the past month, widening spreads in the high yield and BBB indexes suggest that equity market volatility is impacting “equity-like” fixed income, adds Peter Greenberger, director, Mutual Fund & 529 Plan Product Management.

Look for the range to remain tight with a continued bias to a slightly higher range, barring any geopolitical impact, Drabik added.

International

The U.S.-China agreement to pause their trade escalation can be viewed as a short-term face-saving measure that allowed both sides to come away with wins for their domestic audiences as the tougher part is left to be resolved over the next three months, according to Mills.

President Trump is now directly involved in the process, increasing the sensitivity around the final outcome. If negotiations stall and the president comes under increased domestic scrutiny for a lack of progress, we are likely to see a return to an escalatory strategy, Mills noted.

The United Kingdom has forged a tentative Brexit agreement with the European Union, but details on trade relations and other matters are essential to the stability of the UK economy, explains European Strategist Chris Bailey. Expect to see some significant political cajoling before an agreement eventually gets ratified.

Meanwhile, the rest of the European Union is debating the proposed higher Italian budget deficit. The fear is that a higher deficit sets new regional precedents which may lead to instability in the region.

Pan-European markets remain at a discount to their American peers and offer potential for both growth and income-focused investors, if issues such as Brexit and the Italian budgetary debate can be progressed, adds Bailey.

Any signs of compromise will be taken positively. If calmer heads prevail, then 2019 can still offer plenty of opportunity in markets outside of the United States.

Bottom Line

We continue to recommend staying in equities and fixed income, with a bias toward higher quality as late-cycle growth can last for some time, according to Lacy.

Volatility could be an opportunity to buy if you are looking to put cash to work.

Keep in mind that a well-diversified portfolio can help you weather downturns and recover more quickly on the upside.

Also, note that U.S. markets will be closed on Wendesday, December 5. The day has been designated a national day of mourning out of respect for former President George H.W. Bush, who passed away last Friday.

Your advisor will continue to watch for legislative updates as well as economic developments. In the meantime, please reach out to him or her if you have any questions.

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